How Do Indexed Annuities Work?

Indexed annuities are a type of investment that many people choose for retirement planning. This type of investment can provide you with some level of certainty when it comes to your available retirement funds. Here are the basics of indexed annuities.

Indexed Annuities

An indexed annuity is a type of investment that bases its returns on a particular financial index. For example, an indexed annuity might be directly tied to the S&P 500. If the S&P 500 increases in value, the indexed annuity will also increase in value. This type of annuity is different from many of the other fixed annuities available. With a traditional fixed annuity, you will not be subjecting your retirement funds to any investment risk. Instead, you invest your money with the understanding that you will receive a particular rate of return. With the indexed annuity, you are taking on more risk in an attempt to provide yourself with additional retirement funds.

Purchasing an Indexed Annuity

In order to purchase an index annuity, you will need to work directly with an insurance company. This is an insurance product and is not available through a traditional investment broker. Most annuities offer two forms of payment. You could choose to pay for the annuity over a long period. With this option, you will make flexible payments over your working life. You will typically have to make a minimum investment, and then you are free to invest more as you have it.

The other option that you have is to purchase the annuity with a lump sum. Many people will do this once they reach retirement age after saving for many years. Many people have trouble doing this because it involves giving hundreds of thousands of dollars to an insurance company all at once.

Guaranteed Minimum

Although you are exposing yourself to the stock market with this type of investment, you will not be fully exposed. Most of these annuities will have a minimum that you will earn regardless of what the stock market does. This provides you with some level of safety even though you are attempting to benefit from movements in the stock market.

Investment Caps

Although you are able to earn based upon increases in a financial index, there are caps on what you will be able to earn. For example, an annuity might put a cap of 7 percent on what you will be able to earn. This cap will be in place regardless of whether the index earns 15 percent. This means that you have limited potential with this type of investment.


With the indexed annuity, you should also be aware that there will be management fees incurred. The annuity will charge you a certain percentage of the earnings of the investments for management fees. For example, they might charge you 2 to 3 percent, which will come out of the money that was earned from investments.

Indexed Annuity

An indexed annuity is a type of annuity contract that is tied to a financial index. The performance of the annuity will be directly related to the performance of the financial index that it tracks. This type of investment is designed to appeal to individuals who want to have the safety of annuity payments and play the market at the same time.

One of the big differences between this type of annuity and a traditional, fixed annuity is that it provides market exposure to the investor. With fixed annuities, the individual does not get to be exposed to the market. They will receive only the amount of interest that is guaranteed with the annuity contract. With the indexed annuity, the individual can take advantage of favorable market conditions. When the value of the financial index increases substantially, the investor will be able to make a higher return than normal.

Even though the interest rates are tied to the performance of the financial index, there are usually maximums and minimums on how much you can earn with this type of annuity. If the index provides a large amount of return, the investor will usually receive a lower amount of return.

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